NRIs check this before investing in debt market!

For a long time, the only investments that NRIs participated in India were the NRE and FCNR deposits. These were deposit accounts offering substantially higher rates of interest compared to what they would earn in any of the Western or even in the Middle Eastern countries. This arbitrage kept them interested. In the last few years, NRIs have a much wider choice in the form of options like government bonds, private sector debt, gold bonds and even debt funds to invest in. A non-resident would typically have earnings in foreign currency and normally invests in India. What one needs to remember here is that for an NRI it is not just the returns on the instrument that matter but what they earn in effective dollar terms; meaning after considering the currency risk.

One of the major attractions for NRIs to invest in India is the high real rates of interest on debt instruments. For example, the average 10 year bond yields in India pays almost 450 bps over what the US bond pays. This makes India a lucrative investment destination for risk-averse NRIs who are in search of preserving capital or their hard earned money. When compared to the U.S., Euro-zone and the other BRICS nations, India offers substantially higher interest rates.

Debt instruments available to NRIs

Due to the attractive real interest rate scenario (more than 4% net of inflation), India has remained an attractive debt investment for NRIs. Broadly, they can invest directly in bonds / NCDs or indirectly via debt funds and balanced funds. Here are some key options available to NRIs to invest in Indian debt.

Banking deposits; a benign form of debt investment

NRIs have a choice of NRE (Non Resident External), FCNR (Foreign Currency Non Resident) and NRO (Non Resident Ordinary). The NRO account is a rupee account and there are restrictions on repatriation out of the account on earnings in India. The NRE and the FCNR account are freely repatriable accounts without any limits. The only difference is that in an NRE account, the currency risk is with the depositor whereas in case of FCNR deposits, these are dollar / sterling / Euro accounts so there is no currency risk. The rates on FCNR account are much lower and are typically benchmarked to LIBOR. NRIs can choose to maintain a savings account or an FD with the bank. NRIs can also opt for long term FDs with a lock-in of 5 years and claim the benefit of Section 80C when they file returns in India.

Debt instruments that NRIs can invest in

NRIs are permitted to invest in most of the debt instruments that are available in India including corporate bonds, institutional bonds, government securities, short term treasury bills, gold bonds etc. The only restriction is that the NSC (National Savings Certificates) investment by NRIs can only be done on a non-repatriable basis from an NRO resident account of the NRI. NRIs are also permitted to invest in private fixed deposits of corporates and NBFCs, which typically pay higher yields.

NRIs can also invest in a wide array of debt funds

NRIs are permitted to invest in a wide array of debt mutual funds including money market funds. The only condition for money market funds is that NRIs can only invest in them on a non-repatriable basis. The rest of the debt funds can be invested either on repatriable or non repatriable basis. Here is the array of choices.

Liquid Funds: These funds principally invest in very short term money market instruments with maturity up to 90 days as well as in the call money market.

Ultra Short Term Debt Funds: They give slightly higher returns than liquid funds with a slightly higher degree of risk. Portfolio comprises of a mix of certificate of deposits (CD), commercial paper (CP), call money and other money market instrument with slightly longer maturity than liquid funds.

Floating Rate Funds: These work best when interest rates are rising. They invest in short-term instruments offering flexible interest rates reflecting the prevailing interest rate in the country and the yield can be dynamic.

Short Term Income Funds: These funds invest in short-term bonds, deposits and NCDs. They also invest in T-bills and Government securities with maturity of less than 3 years

Gilt Funds: Invests only in securities issued by the Central and State Government. These are normally the safest investments with almost no default risk for NRIs.

FMPs (3 to 36 months): These are closed ended funds and have a risk of quality although the interest rate risk is largely eliminated. FMPs have been in the news for all the wrong reasons in the recent past.

Before investing in debt, NRIs must set out the time horizon as that will determine their liquidity requirement. That is the first step!